What you miss by not reading the most important economics book of the decade

Wednesday

Aug 6, 2014 at 6:00 AM

By Peter S. Cohan WALL & MAIN

Princeton economics professor and New York Times editorialist Paul Krugman wrote, "It seems safe to say that 'Capital in the Twenty-First Century,' the magnum opus of the French economist Thomas Piketty, will be the most important economics book of the year — and maybe of the decade."

On August 3, I finished reading the English translation of "Capital in the Twenty-First Century," and have come to the conclusion that Mr. Krugman's commentary tells us more about the quality of economics books these days than it does about the value of Mr. Piketty's work.

Before getting into that, I will try to summarize the point of this 696-page tome. Mr. Piketty's goal is to rebuke the economics profession for idolizing mathematical theory, as Princeton's economics department does; or story-based political advocacy, ie. his interpretation of Karl Marx's "Das Kapital"; by using meticulously crafted spreadsheets to put economics in centuries-long perspective.

In so doing, Mr. Piketty starts with hundreds of years of French data on the transfer of wealth through estates, and he also collects figures on economic growth, capital, income, assets, debt, and investment returns. While frustrated that other countries are not as obsessive and meticulous about this as France, he tries his best to collect comparable statistics for other Western countries such as England, Germany and the United States.

After plowing through about 600 pages of turgidly written and poorly translated French — in a single paragraph, the volume used the same common French expression 'it is perfectly possible that' twice — I did not have the patience or interest to also visit the online links to his spreadsheets, and go back and evaluate whether he did a reasonable job of assembling his statistics. I also do not have the knowledge to assess how well or poorly he did this.

Mr. Piketty's conclusion is that income inequality was very high before the French Revolution, and it is growing back to that level now. He indulges in the same rhetorical flourishes he criticizes by arguing that catastrophe awaits the world unless this trend is stopped. His solution is a global tax on capital — a proposal that would require every country in the world to agree on tax rates for varying amounts of capital. Absent that, he wants governments around the world to produce rigorous data on wealth so he does not have to rely on shoddy outlets like Forbes.

I believe that such a global tax on capital will never happen and that his concerns about income inequality may be real in France — which went through a revolution in 1789 to counter the wealth and power of its aristocracy.

However, people in the U.S. do not care much about income inequality. I have not forgotten that about three years ago, the Occupy Wall Street movement got quite a bit of press attention. However, it is also clear that besides introducing the amusing practice of human microphones, OWS did not change anything.

What is interesting to note about Mr. Piketty's numbers is that they demonstrate an understated admiration for the value of massive amounts of violence. More specifically, the book repeats over and over again the idea of U-shaped curves — a clinical reference to the steep decline in the ratio of capital to income in the countries he analyzes — as a result of World Wars I and II.

As he repeats many times — capital is a stock and income is a flow. By that he means that capital is money left over after subtracting debts from the value of assets held by companies, individuals and governments. Income is the cash that flows into their coffers.

(I view capital and income as different states of the same thing — like water than can be a solid, a liquid or a gas. Capital becomes income if it is invested in projects that hire people — giving them income — and generating a return for companies which takes the form of flows to their shareholders as well as adding to their stock of capital.)

And Mr. Piketty's U-shaped curves reveal that before the French revolution, the ratio of capital to income was about 600 percent, after the World Wars it plunged to around 200 percent, and it has gone up since then and it is now back to around 600 percent.

Mr. Piketty also collects statistics on income inequality, which show that in the U.S. more than other western countries, the top fraction of individuals controls an enormous share of the income and capital.

But the reality is that this does not bother most Americans enough to foment the kind of violent political or economic upheavals needed to reduce the inequality. Americans generally seem to admire people like Bill Gates, Mark Zuckerberg, and Steve Jobs, who create new products that people want to buy, and get rich in the process.

To be fair, they do not seem to hold bankers and hedge fund managers in such high regard, since they seem to make huge amounts of money without adding much value to society. Moreover, there have been high profile cases of hedge funds that have made money through insider trading, and bankers who were bailed out with taxpayer money when their debt-ridden concoctions blew up in 2007.

The ultimate problem with Mr. Piketty's argument is his fetish with centuries-long series of numbers. He seems convinced that all economies are fated to grow at a mere 1 percent and that rates of return on capital will "always and everywhere" — another one of his favorite expressions — be 4 percent.

And with rates of return on capital being higher than economic growth, it is inevitable that the world will be divided into an ever-smaller number of people who inherit vast wealth and live off the interest while most people struggle for economic oxygen.

The recent reality is at odds with Mr. Piketty's vast spreadsheets. U.S. economic growth has averaged about 2 percent for the last few years and was 4 percent in the most recent quarter as job growth rose above 200,000 per month. Moreover, the stock market has been providing economic returns that are much higher than his 4 percent — nearly 18 percent a year since 2009.

Americans are not obsessed with class envy the way Mr. Piketty seems to be in his subtle way. If an American family has enough to live comfortably, it is not willing to engage in organized violence or raise taxes dramatically to somehow level the economic playing field.

Perhaps the biggest danger we face — one which Mr. Piketty ignores — is the growing role of corporate money in our political dialog thanks to the 2010 Citizens United case that equates money with speech.

For now, it seems that enough voters can hear through the sound of that money to check its power. Rather than a global tax on capital, I'd be happy with a law that reverses that act of legislating from the bench.

Peter Cohan of Marlboro heads a management consulting and venture capital firm, and teaches business strategy and entrepreneurship at Babson College. His email address is peter@petercohan.com.